Hackett Advisors in the News

By Whitney McFerron, Elizabeth Campbell and Jeff Wilson - Mar 14, 2011 3:56 PM ET

Milk Seen Plunging 14% as Costliest Cheese in Quarter Century Curbs Demand

The milk rally that sent prices up 48 percent this year, more than any agricultural commodity, may be ending as farmers respond with record production and the costliest cheese in a quarter century curbs demand.

Output in the U.S., the world’s second-largest producer, may rise 1.7 percent to 196 billion pounds in 2011, enough to fill about 34,500 Olympic-sized pools, the Department of Agriculture estimates. Demand will weaken as restaurants cut promotions and grocers raise prices, said INTL FCStone Inc., a New York-based broker. Futures may drop 14 percent to $16.86 per 100 pounds by Dec. 31, a Bloomberg survey of 10 analysts showed.

Dairies are missing out on profits from milk’s biggest rally since at least 1996 as the surge in grain that drove world food prices to a record, contributing to protests in northern Africa and the Middle East, also boosted the cost of feeding cows. While income for grain and cotton growers will rise more than 20 percent this year, earnings at dairies may drop 13 percent, the government estimates.

“Grain farmers are having some of the best years they’ve had in a long time profit-wise, but you couldn’t say that for dairy,” said Bob Cropp, an economist at the University of Wisconsin in Madison who has been studying the industry since 1966. “Dairy facilities are running at the maximum. With a little softening in demand, prices are going to come down.”

Milk futures on the Chicago Mercantile Exchange fell 0.2 percent today to $19.61 in Chicago, after reaching a 32-month high of $19.65 on March 11. Prices are up 53 percent from a year earlier as importers from Mexico to China increased buying and the rebounding U.S. economy bolstered domestic demand.

Commodities Rally

Milk’s 2011 rally has exceeded those of all agricultural futures traded in New York and Chicago including cotton, which surged 42 percent and reached a record last week. The Standard & Poor’s GSCI Index of 24 commodities advanced 11 percent, and the S&P 500 Index of stocks rose 3.7 percent. As of March 10, Treasuries gained 0.1 percent this year, a Bank of America Merrill Lynch index shows.

Traders are already anticipating a drop, with the December contract at a 16 percent discount to the one that expires this month. Shawn Hackett, the president of Hackett Financial Advisers, who correctly projected in October that milk would surge, now says futures for Class III milk, used to make cheese, may fall as low as $15 amid higher output in Australia and New Zealand, the largest exporter.

Food Inflation

Riots have erupted from Bahrain to Morocco, in part fueled by food costs the United Nations says reached a record last month. Protests already toppled leaders in Egypt and Tunisia. The projected drop in milk prices will do little to relieve the surge in food inflation that the World Bank says helped drive 44 million more people into extreme poverty since June.

Milk’s rally may continue for several more months because exports will support prices, said Jerry Dryer, the Delray Beach, Florida-based publisher of the Dairy & Food Market Analyst, who has been following the industry for three decades.

Shipments surged 63 percent to $3.7 billion last year, nearing the 2008 record of $3.8 billion, U.S. Dairy Export Council data show. Cheese exports rose to an all-time high, and milk-powder sales climbed 61 percent, the Arlington, Virginia- based trade group said.

U.S. exports rose as New Zealand boosted sales to China, said James Dunn, an economist at Pennsylvania State University in University Park. China bought about 353 million kilograms (778 million pounds) last year, compared with 69 million kilograms in 2008, according to New Zealand government data.

Last Rally

Milk’s last advance of this magnitude ran for 15 months through June 2007, when it more than doubled to a record $22.45. Prices would have to advance 14 percent more to match that peak.

“This rally will last at least a full year before rising production catches up with demand,” said Dryer of Dairy & Food Market Analyst.

Consumption may not support the gains much longer, said Mary Ledman, a former economist with Kraft Foods Inc. U.S. milk production this year may begin rising in April and May, just as retailers start increasing prices to shoppers, she said.

Safeway Inc. (SWY), the fourth-largest U.S. supermarket chain by sales, said Feb. 24 that it began to pass higher costs to consumers during the fourth quarter, including for milk.

“Retailers’ margins in the dairy case, and particularly on fluid milk, have been squeezed since 2010,” said Ledman, who owns the Libertyville, Illinois-based consultant Keough Ledman Associates. “I don’t think they have any choice but to raise retail-milk prices in 2011.”

Ice Cream

Whitey’s Ice Cream, which has 11 stores in Illinois and Iowa and sells to about 100 retail outlets including Wal-Mart Stores Inc., may boost prices in coming months because costs for milk, cream and sugar have jumped about 50 percent from a year ago, said Jeff Tunberg, who owns the Moline, Illinois-based business with his brother.

“Ice cream has been recession-resistant, but not recession-proof,” Tunberg said. “We’ve been in business for 78 years, and we’ve always had a model that we will raise our price before we will change our quality.”

Cheddar cheese in supermarkets averaged $5.143 a pound in January, the highest since at least 1984, while a half gallon of ice cream sold for $4.74, the most since 1980, according to data collected from about 26,000 retailers by the Bureau of Labor Statistics. Retail whole milk averaged $3.301 a gallon, 2 percent more than a year earlier.


U.S. food inflation accelerated 0.9 percent in January, the fastest monthly pace since June 2008, when prices were headed for their biggest annual gain in 28 years. Costs will rise as much as 4 percent this year, more than the 2 percent to 3 percent estimated in January, the USDA said last month.

Higher prices don’t mean improved earnings for dairy farmers because corn, the main feed ingredient, is 82 percent costlier than a year ago. In California, the biggest milk producer, feed costs made up about 84 percent of the price farmers received for milk in December, according to USDA data.

The average net-cash income, or earnings used to pay most expenses and debt, for American dairies will decline to $184,000 this year from $212,100 in 2010, a bigger drop than for producers of beef cattle, hogs and poultry, the USDA estimates.

Dairy Profit

Higher milk prices still allowed dairies to earn $1.18 per 100 pounds of milk at the end of February, compared with 21 cents at the same time last year, said Chip Whalen, a senior risk manager at Commodity & Ingredient Hedging LLC in Chicago.

The herd will rise 0.4 percent to 9.154 million cows on average this year, the first annual increase since 2008, the USDA estimates.

Cows produced on average 21,149 pounds (9.59 metric tons) last year, more than double the amount in 1970, according to the USDA. Changes to breeding methods mean more females are being born. Farmers also maintain younger herds by slaughtering older cows when their milk output slows.

Productivity probably will increase in the next few months to a seasonal peak that will exceed the monthly record of 1,893 pounds reached in May, said Joel Karlin, the commodity sales coordinator for Western Milling in Goshen, California, which makes feed for dairy farms.

At the same time, higher prices will curb demand from consumers, erasing profit for producers that don’t grow their own feed or hedge their grain costs, said Robert Chesler, a Chicago-based vice president of food service for INTL FCStone.

Food Promotions

“Daily buying has been led by promotions and specials, two-for-$10-pizza deals, things like that,” Chesler said. “That’s going to be a difficult thing to continue in 2011, because of the price increases in commodities, so demand domestically could certainly take a little bit of a pullback.”

Oberweis Dairy Inc., a processor based in North Aurora, Illinois, that buys milk from farmers, increased the retail price of half-gallon, glass-bottle milk products by almost 7 percent as of March 1, Chief Executive Officer Joe Oberweis said. The 84-year-old company’s milk cost has doubled since 2009, he said.

Farmers are “a little bit more optimistic at this point, but, still, nobody’s jumping up in the air and kicking their heels,” said Joyce Bupp, a 65-year-old farmer who owns a 170- cow dairy in Seven Valleys, Pennsylvania.

U.S. milk production may continue to rise, said Michael Swanson, a Minneapolis-based economist at Wells Fargo & Co., the largest U.S. agricultural lender. Producers “expand when prices are good and expand when prices are bad,” he said.


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